Financial markets brace for default as Biden, Republicans dig in on debt limit

The partisan standoff over the debt limit, which hardened over the weekend when 43 Senate Republicans said they would not support a clean debt-limit increase, sets the stage for severe turbulence in the financial markets, experts warn.

The yield on Treasury bonds maturing next month spiked last week, signaling that investors are already preparing for the possibility that President Biden and Republican leaders in Congress won’t reach a deal before the Treasury Department runs out of money next month.

Biden will meet with the top four congressional leaders at the White House Tuesday to discuss how to avoid a default, but lawmakers expect little progress from the meeting. It’s the first face-to-face meeting between Biden and Speaker Kevin McCarthy since Feb. 1.

There’s growing pessimism in Washington and the financial markets that political leaders will negotiate a long-term deal by early June, the deadline set by Treasury Secretary Janet Yellen.

If an agreement doesn’t come together in the next month, congressional leaders will have to agree to a short-term extension of the debt limit to give themselves more time to negotiate.

Without a short-term agreement, the US would go past the so-called “X-date” and face major turmoil in the markets.

“I genuinely believe there’s a better-than-50-percent chance that there will be default, it will occur over a weekend and when the chaos it creates becomes obvious to all the players, they’ll have to reach some sort of accommodation,” said former Sen. Judd Gregg (R-N.H.), who previously served as Senate Budget Committee chairman and an advisor to Senate Republican Leader Mitch McConnell’s (Ky.) leadership team.

“The potential is pretty dire,” he warned. “Right now, you don’t have the leadership to solve the problem, that’s the bottom line.”

Gregg said McCarthy faces a challenge to his speakership if he brings a debt-limit bill to the House floor without major fiscal reforms, but the cuts that he’s proposing don’t have a chance of passing the Senate.

McConnell’s support for a letter signed by 43 Senate Republicans declaring they will not support “any bill that raises the debt ceiling without substantive spending and budget reforms” has failed to move Democrats away from insisting on a clean debt-ceiling increase.

“I don’t know what Democrats have to negotiate,” said a senior Senate Democratic aide, who pointed out that Republicans agreed to raise the debt limit three times under former President Trump without drama. “We’re not the ones being inconsistent.”

“At the end of the day, a lot of their behavior is playacting,” the aide said, predicting a spike in stock and bond market volatility will pressure Republicans into backing off their demands. “They have investments, too.”

The aide, pointing to the downgrade of the nation’s credit rating in the 2011 debt-limit standoff, said that this year’s battle in Washington over the debt ceiling would also shake the financial markets.

“We have in the past. I don’t know why this would be different,” the aide said.

Financial markets are already starting to show signs of stress related to the impasse over the debt ceiling.

One-month Treasury bills maturing around a projected date in early June, when the government could run out of money, saw their yields spike to 5.76 percent last week.

Yields have climbed far above recent averages closer to 4.5 percent and significantly higher than the recent low of 3.3 percent in April.

“The Treasury bills curve appears to imply risk of disruption in June, July, and October,” Goldman Sachs chief economist Jan Hatzius wrote in a note last week to investors.

Treasury bills maturing in early June were trading at more than a 50-basis point discount compared to May and July at the end of last week.

“Investors are paying a healthy premium to own bills that mature in May while demanding hefty compensation to hold T-bills that are maturing in the first half of June,” analysts for Wells Fargo wrote in a note to investors last week.

Wall Street insurance policies, which are known as credit default swaps, against one-year Treasuries hit a record-high spread of 1.77 percent late last week in a spike that was notable both for its timing and its size.

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